Why bond investors should not panic when interest rates rise

Bonds have been under pressure lately because of possible 4 times interest rate hikes because of inflation. Everyone is looking at the 10Y US Treasuries yield which currently stands at 2.87. Many analysts are saying the same thing, but I shall quote Schroders in a recent SIAS report, “based on our models, US equity valuations are sustainable as long as US 10Y yields does not go above 3%”. Yet, when I look back in Dec 2013, the US 10Y yield stood at 3.03%. Now what happened back in 2013 to 2014? It was then a great bull run for US stocks!

I should not be too cocky. It is not what I think that is important, but what most people are thinking.

This article is mainly about US Treasury bonds and bond funds, but in some ways is also applicable to corporate bond investors. Read for yourself, but I shall extract a portion here for you my readers:

“history shows bond funds tend to recover from downturns, providing positive returns over the long term, according to analysts at AllianceBernstein.

“Since 1993, the Bloomberg Barclays US Aggregate Index, dominated by government and investment-grade corporate bonds, fell 1.2% on average during months when yields increased by at least 0.3%. But it rose 2.6% over the next six months,” AllianceBernstein wrote.

“Over the short term it may seem like there is no place to hide when your stocks are falling and your bonds are hit. But focusing on the short term when it comes to bonds is counterproductive,” said Dana D’Auria, managing director at Symmetry Partners, a Glastonbury, Conn.-based asset manager.

“In a scenario like now, people would think that going to cash is a good option. The problem with that is you don’t know when to reinvest that cash. Sitting in cash means that there is always an opportunity cost,” D’Auria said.

A year after the 1% spike [in yields], the seven-year U.S. Treasury whose duration is similar to the U.S. Aggregate’s, would be down almost 2%. But over time, higher yields lead to higher returns. Our analysis suggested that investors who sat tight for three years and reinvested their coupons could have earned a cumulative return of 6%. Six years later, the return in our analysis was nearly 17%,” AllianceBerstein wrote.”

For me, I do not have access to these models and historical data. However, as a bond investor, I am not panicking when interest rates rise:

the most important factor for bond investors is credit risk. Get this right, and the risks will be minimum. Interest rate rise does not really hurt me in the long run. It simply reduces my returns.

if I were to hold bonds till they mature, falling bond prices does not matter.

if interest rates were to rise, and upon maturity, the principal can be reinvested in bonds with high yield.

If you would like to construct a resilient bond portfolio like I have, please contact me.

I'm a remisier with Maybank Kim Eng, and as a bonds and REITs investor myself, I guide my clients to build resilient bonds and REITs portfolios. If you like to be guided, please contact me regarding how to become my client; It's free!